Dodd-Frank: Regulation Cannot Build Character

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Dodd-Frank regulations, originally scheduled to take effect on July 16, are intended to create market stability. Instead, they are doing just the opposite.

Regulations aimed at financial derivatives, incorporated into the Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law last July, have recently been rescheduled to take effect on December 31. The regulations are aimed at reducing the risk of derivatives, a contentious issue among those debating the root cause of the financial crisis. A Reuters’ report suggests this legislation will create uncertainty and a legal void for the derivatives market. Fears that trades could be challenged or invalidated may send the market for swaps (over-the-counter derivatives) into “legal limbo,” according to NASDAQ News.

I have concerns that this proposal will not provide the appropriate level of legal certainty, and if it is to last only a few months, will likely only serve to further confuse and frustrate the markets and market participants.

Legal delays and uncertainties are only a small part of a much larger problem. Saturated with 2,253 pages of confusing regulation, Dodd-Frank is considered to be the most drastic financial revision in 80 years.

Former U.S. Senator Judd Gregg, now an adviser to Goldman Sachs, says Dodd-Frank goes too far for our good. He argues the regulation will hurt job creation and smother economic growth:

The consequences will be a massive transfer of economic activity overseas and an equally massive contraction in the liquidity and credit that keeps U.S. business competitive and vibrant.

Though intended to stabilize the financial market, Dodd-Frank is creating more uncertainty and instability at our liberty’s expense. Regulation will harm competition and stifle individual freedom. In an attempt to correct the immoral behavior on Wall Street, the government is compromising the dignity of the individual by reducing financial choices.

In a commentary titled “Credit Crunch, Character Crisis,” Samuel Gregg, the Director of Research at the Acton Institute, discusses the financial and moral costs of similar risk-controlling regulation in the past:

A longer-term problem is that this failure may facilitate calls for more financial regulation, much as the Sarbanes-Oxley Act was a response to America’s 2000-2001 corporate scandals. The evidence is growing that Sarbanes-Oxley has proved extremely costly for business. Even Sarbanes-Oxley’s authors now concede many of its provisions were badly drafted.

According to a University of Pittsburgh study, Sarbanes-Oxley’s discouragement of prudent risk-taking and its generation of additional compliance-costs have contributed to many firms listing themselves in the City of London rather than Wall Street. This has also been facilitated by Britain’s Financial Services Authority’s shift away from Sarbanes-Oxley-like procedural approaches to financial regulation, towards principles-based regulation which focuses on (a) the behavior reasonably expected from financial practitioners and (b) good outcomes.

In the end, however, no amount of regulation — heavy or light — can substitute for the type of character-formation that is supposed to occur in families, schools, churches, and synagogues.

These are the institutions (rather than ethics-auditors and business-ethics courses) which The Wealth of Nations’ author, Adam Smith, identified as primarily responsible for helping people develop what he called the “moral sense” that causes us to know instinctively when particular courses of action are imprudent or simply wrong — regardless of whether we are Wall St bankers or humble actuaries working at securities-rating agencies.

Perhaps the recent financial turmoil will remind us that sound financial sectors rely more than we think upon sound moral cultures.

Gregg’s economic and moral analysis suggests regulation cannot build character. The implicit goal of Dodd-Frank is to achieve moral ends on Wall Street through coercive means — expanding government oversight. We must remember virtue cannot be artificially manufactured by increased regulation; rather virtue requires freedom to choose the proper course of action. Moral character in the business world should be encouraged by a proper incentive structure, but even more importantly by the values taught in our social institutions.

Elise Daniel
Elise Daniel is a freelance writer and communications consultant in Washington, DC. Previously, she served as the Press Secretary for the House Committee on Natural Resources, a senior writer for the Institute for Faith, Work & Economics, and has also worked at
the U.S. Chamber of Commerce, the Values and Capitalism Project at the American Enterprise Institute, and the Acton Institute. She graduated from James Madison University with a BBA in Economics. She is the editor and co-author of
Called to Freedom: Why You Can Be Christian and Libertarian.
Her articles have been published in RELEVANT Magazine, Real Clear Religion, the Gospel Coalition, The Federalist, Patheos, and the Daily
Caller, among others.

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Comments

It is not surprising that two of the people most responsible for the collapse of the housing and financial markets have authored a law that ignored the cause of the problems while burdening the industry further — nice going boys!

INSURANCE
Federal Insurance Office: Creates the first ever office in the Federal
government focused on insurance. The Office, as established in the
Treasury, will gather information about the insurance industry,
including access to affordable insurance products by minorities, low-
and moderate- income persons and underserved communities. The
Office will also monitor the insurance industry for systemic risk
purposes.

Oh great… just what we need, more government offices that ultimately hope to control another thing in our lives. That document is ripe.

I agree with most of what you’ve written. My question is whether government regulations can reinforce or encourage good character?

Elise Amyx

Thank you for your question. As stated in my post, I do not
believe regulation can encourage character. First let me make a distinction
between just laws (that protect property rights, human rights and prevent fraud)
and overreaching economic regulation. Assuming these laws are moral, they can
help us recognize when we are acting immorally, which may or may not encourage
good character depending on the person. However I do not believe overreaching economic
regulation as seen in the Dodd-Frank Act can encourage character. Yes, it may
prevent SOME immoral behavior, but the persons who may have otherwise acted
immorally are only abstaining out of fear of punishment, not because they
suddenly have the character to make the moral choice. This is because a true change
in character is derived from a change in heart, not a change in regulation. Businesses
and financial institutions are more effectively kept in moral check with
proper incentive structures that reward good behavior and punish bad behavior.
Effective incentive structures exist in markets free markets with a well
defined legal system protecting against theft, fraud, etc.

Elise Amyx

Thank you for your question. As stated in my post, I do not
believe regulation can encourage character. First let me make a distinction
between just laws (that protect property rights, human rights and prevent fraud)
and overreaching economic regulation. Assuming these laws are moral, they can
help us recognize when we are acting immorally, which may or may not encourage
good character depending on the person. However I do not believe overreaching economic
regulation as seen in the Dodd-Frank Act can encourage character. Yes, it may
prevent SOME immoral behavior, but the persons who may have otherwise acted
immorally are only abstaining out of fear of punishment, not because they
suddenly have the character to make the moral choice. This is because a true change
in character is derived from a change in heart, not a change in regulation. Businesses
and financial institutions are more effectively kept in moral check with
proper incentive structures that reward good behavior and punish bad behavior.
Effective incentive structures exist in markets free markets with a well
defined legal system protecting against theft, fraud, etc.

Roger McKinney

Excellent reply. Of course, the question of whether regulation or the free market controlled greed better was the main point of Adam Smith’s ‘Wealth of Nations’.

The “regulatory capture” theory explains why regulations encourages corruption rather than virtue: politicians appoint regulators. Politicians crave campaign funds, which they get from corporations. Large corporations contribute the most, but with strings attached. The politicians they contribute to must appoint people to the regulatory agencies that the corporations approve of. So the corps being regulated “capture” the regulatory agencies. It’s the old fox guarding the hen house problem.